If you have a credit card that you’ve successfully paid off in full, and perhaps feel that you’d be better off without for one reason or another, you might be considering cancelling it and closing the account altogether.
But when it comes to making decisions about credit products, having your credit score front of mind is never a bad idea. After all, your credit score is determined by your credit activity.
So, it’s reasonable to wonder whether ditching your credit card could negatively impact your credit score.
The short answer is that cancelling a credit card could hurt your credit score, but that doesn’t necessarily mean it will.
Australian credit reporting bureaus don’t disclose exactly how each kind of credit event will affect your credit score, but generally speaking, it will depend on a number of factors.
In what ways could cancelling a credit card hurt your credit score?
There are several different situations in which cancelling your card could result in a lowered credit score, some of which are as follows:
1. You’ve decided to switch to another credit card product
If you’re considering closing your existing credit card and applying for a new one, there is a chance you could harm your credit score in the process – even if you believe the new card will better suit your needs.
This is because each time you submit an application for credit, a new enquiry is recorded on your credit file. Having a large number of credit enquiries on your file could show lenders that you aren’t in control of your finances or are otherwise desperate for credit.
However, if this is the first time you’ve switched cards, there’s a chance it might not have an impact on your credit score at all. Plus, there are plenty of valid reasons you might want to jump ship, such as securing a lower interest rate or switching from a basic low-rate credit card to one that can earn you rewards.
Weighing up the pros and cons and considering your own personal circumstances is the best way to decide what’s right for you.
2. You’ve only had it for a short period of time
If you’ve only had your credit card for a short period of time before cancelling it, you won’t have the opportunity to demonstrate to lenders that you are a responsible long-term borrower.
Additionally, closing your credit card after only a short time could lead lenders to believe that you don’t trust your own spending habits.
Even if you took out your credit card for a specific reason, such as to have some extra spending money on your holiday, and no longer require it, it could be worth considering holding onto it for a bit longer.
Just keep mind that even if you aren’t using it regularly, you will typically be charged some sort of fee to keep your account open, such as an annual fee.
3. It’s your only form of credit
Since the introduction of comprehensive credit reporting, both negative and positive information is recorded on your credit file. Negative information could include late payments or over applying for credit, while positive information could be consistently paying your bills on time over a long time period.
Comprehensive credit reporting gives you the opportunity to prove to lenders that you are a responsible borrower. If the credit card that you are thinking about cancelling is your only form of credit, you will no longer be able to demonstrate this, meaning lenders may have less confidence in your reliability.
In what instance might cancelling a credit card benefit your credit score?
There are also a number of circumstances in which cancelling your credit card may be beneficial to your credit file, including the following:
1. You often find yourself tempted to use it on unnecessary purchases
If you feel that having access to credit could lead to the temptation of making unnecessary purchases, cancelling it might help you avoid building your debt up to an unmanageable level, causing late or missed payments.
If you were to hang onto your credit card in this instance, you could cause damage to your credit score.
Remember, if you are experiencing financial strain, you can reach out to the National Debt Helpline to receive free advice from a financial counsellor.
2. You want to improve your debt-to-income ratio
Your debt-to-income ratio is the amount of debt you have in comparison to your overall income.
The thing with credit cards is that even if your balance owing is zero, lenders tend to consider the entire credit limit of your card as a debt. This is because since you have access to that amount of money, you could technically decide to spend it all at any given moment.
In order to comply with responsible lending conduct obligations, lenders take your debt-to-income ratio into consideration when deciding whether to approve an application for credit.
So, if you’re planning to apply for a substantial loan, like a home loan, it might be worth considering improving your debt-to-income ratio by eliminating unnecessary credit cards. Alternatively, you could request to have your credit card limit reduced.
3. You have multiple credit cards or other credit products
If you’ve paid off one of multiple credit cards and you’ve simply got no use for it, it could make sense to cancel it, and it’s unlikely that doing so will have much of an impact on your credit score. The main reason for this is that you still have other forms of credit in use that tells lenders what kind of a borrower you are.
How to make the right decision for you
At the end of the day, the decision you make should be based on your own personal circumstances and what will put you in a better position. The best way to do this is to consider all of the consequences you may face by cancelling your credit card and weigh up the pros and cons of each.
For more information specific to your personal financial situation, consider reaching out to a financial adviser.
